Oil Money

The sky-high price of crude oil is fueling a private equity boom in the Middle East. In the past nine months, more than 90 new venture capital and private equity funds have been launched. They are collectively seeking to raise in excess of $40 billion from family offices, development authorities, high-net-worth individuals, royal families and Mideast governments. Private equity funds, meanwhile, are poised to corral more than $30 billion of that sum, up from less than $1 billion in 2005. Now if only U.S. investors could just figure out how to get their hands on some of that money.

Nearly every one of the 90-plus funds raising money is either based in the Middle East or plans to invest its money there. For a variety of reasons—including worries that legitimate Mideast investments in U.S. funds could be seized due to anti-terror efforts—only a portion of the region’s newfound wealth is flowing into U.S. private equity funds. Instead, most of the money is staying within Arabian borders, where a new home-grown private equity industry has emerged, seemingly overnight.

Abraaj Capital’s Arif Naqvi, has seen the industry’s emergence first hand. Naqvi, the CEO at the Dubai-based firm, cites, “The Gulf and surrounding region is experiencing a period of sustained and fundamental growth supported by positive policy developments and an increasing focus on capital allocation.”

In terms of fund size, most of the funds being raised are in the range of $100 million to $500 million. About 10 are $1 billion or larger and several are in the range of $50 million to $100 million.

It is worth noting that at least one expert in the region is skeptical that all of the funds that have been announced will actually get raised. Imad Ghandour, a principal at investment bank Gulf Capital, predicts that some of the new funds will never see the light of day.

9/11 reverberations

Probably the most important factor driving the changes in finance in the Gulf Region is the fact that “Arab investing has turned inwards in the post 9/11 era,” according to one source who heads a Gulf-based investment firm.

Since that time, the region’s investors, who are notoriously covetous of their privacy, had justifiable reservations about investing in Western countries. “[Following 9/11], you had to be worried that your money or assets would be seized by the government in the United Kingdom or in the U.S. in their reaction against terrorism,” adds the source, who asked to remain anonymous.

In the wake of Sept. 11, 2001, a substantial portion of legitimate Gulf investment capital fled the United States and the United Kingdom, and “there is great reluctance to return,” says the head of a separate private equity group based in Bahrain. “Just look at the Bin Ladens. They were a big investor in The Carlyle Group, but after 9/11 they cashed out.”

Moreover, the fierce U.S. backlash over plans for Dubai Ports to takeover certain U.S. assets gave further evidence to Arab investors that their money was not welcome in U.S. destinations. The result of all of this is, “Local LPs are investing in local funds for local investment,” says Kasheed M. Almaraj, governor of the Bahrain Monetary Agency. “We’re no longer looking outward.”

In the wake of 9/11, there has been a surge of Pan Arab nationalism across the often-fragmented Islamic community in 55 different countries, giving the people of the Gulf Region more reasons to invest in communities with religious, cultural, familial and business ties. The result has been an eruption of nation-building throughout the Gulf, as Arab funds are redirected to Arab economies and Arab businesses.

If there has been any outward investment, it generally is confined to nearby regions, including India, Pakistan, North Africa and South East Asia. There is also talk of Mideast capital making its way into East Africa, with Sudan being the most often mentioned destination, as well as the former Soviet Republics.

Where the money flows

The oil profits gushing into the Middle East have more then doubled in the last two years and have created a boom in both public and private equity. Saudi Arabia’s stock market, which is open only to investors from within the country, shot up from 4,000 points in 2003 to over 20,000 points in the spring of 2006. That five-fold increase dwarfs even the spectacular growth of India’s BSE, which has increased 2.5 times in value in the last four years.

At the same time, oil money is flooding into the nascent Middle East private equity market. “Up until three to four years ago, it was very difficult to find LPs who had any interest in investing in local ventures,” says Ibrahim S. Al-Mishari, a partner in DevCorp, a Saudi Arabia-based venture development and investment boutique that is raising its first fund.

Most of the new entrants in the market categorize themselves as either growth or expansion-stage firms. Another chunk, totaling 17 funds in all, identifies themselves as private equity or late-stage investors.

“Private equity is still in an early stage and access to good deals can prove difficult,” says Abe Saad, managing director of Shuaa Partners, a $200 million fund based in Dubai that makes growth and expansion investments. “GPs should adopt an opportunistic approach by focusing on both control and minority investments.”

The new funds are primarily being started by three groups: family offices, financial institutions and government institutions. However, divining exactly where capital is coming from can be tricky.

“It’s not like working in the United States, where if you want to know who owns something, say a piece of land, you go to the county registrar who gives you a copy of the ownership document,” says one well-connected Mideast investor. “You have to ask permission to obtain that information.” And that permission is rarely easily obtained.

With that said, there are signs that the reclusive nature of the Mideast investor is changing. Like their counterparts in China and India, Mideast entrepreneurs, money managers and investment professionals who have been trained in the West are going home to help build their countries’ private equity industries. For example, Rabea Ataya, who grew up in Kuwait before attending Stanford University, now runs a job and recruiting Website in Dubai called Bayt.com.

“Institutional PE investing in the region is a relatively new market, but there is an emerging group of managers for non-regional LPs and GPs to work with today,” says Alan Hyslop, senior vice president with Dubai International Capital, which makes private equity investments in Mideast health care, technology, real estate and other sectors.

Mideast hurdles

The most obvious issue facing every private equity firm in the Gulf Region is political instability, as evidenced by the recent flare-up between Israel and Hezbollah, a militant group based in Lebanon.

As it relates strictly to investing, there are other issues as well. For one, while there is plenty of private capital, it is unclear whether all of that money can be deployed profitably. The biggest problem in the region for the venture and private equity industry is the lack of entrepreneurial spirit and the desire of conservative families to maintain control of their family founded businesses.

“Most businesses are family owned, and accepting a new partner, irrespective of the purchase multiple, is a major hurdle,” says Ali Tabbara, CEO of Strategia, a Beirut, Lebanon-based firm that’s raising a late-stage venture fund.

Winning new deals is just half the battle. Finding avenues through which to unload investments can be just as tricky. The region simply doesn’t have the depth of capital markets needed for exits, says Abraaj Capital’s Naqvi. Stock markets in the region, while growing, are subject to big swings. In the past few months, the Saudi Arabian stock market was off by nearly 25 percent.

Moreover, the nascency of the private equity industry in the Mideast means that many investors have little in the way of track record. There are few firms that have proven they can withstand the political turmoil, find deals and realize exits. Abraaj, one of the more successful groups in the region, has only notched two exits out of its debut buyout fund, although both were wildly profitable.

But despite the challenges, investors are keen to plough ahead and many of the tenets that apply to other emerging markets are suited for the Mideast as well.

“Opportunity in the market is growing, but the key is in creating deals as opposed to getting ‘cooked deals’ in mature markets,” says Rakesh Wahi, founding partner of Dubai-based Capital Management Advisors, which is raising $50 million private equity fund. “Understanding of people and culture along with creativity is critical for success.”